TBL Thinks: Changes in the US economy and explaining the Japanese yen carry trade fireworks

Sep 05, 2024

Dear Readers,

It’s Thinking Time! This week we dive into the US economy and how smaller-sized startups are affecting it, how Americans have never been more bullish on stocks amidst increased scrutiny of AI companies, and the sharp reversal of the yen carry trade.

TBL Thinks is our way to summarize the most important paywalled, longer reads relevant to global macroeconomics, helping you cut through the noise. With that in mind, please enjoy.

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Smaller Startups Reshaping the Economy

Rise of the Pint-Sized Startup is Reshaping the US Economy (WSJ) The rise of the gig economy, remote work, and availability of software tools have all led to a rise in new businesses, but a decline in the number of people these new businesses are employing. Inflation and a tight job market have also forced new business owners to start small and do more with less.
Newer businesses are able to thrive with few employees and independent contractors, sometimes spread across the globe. Keeping the headcount low also allows for these new small businesses to adapt quickly to economic cycles. However, UCLA economist Robert Fairlie contends that this flexibility while great in the starting phases can end up hurting during growth phases, since contractors tend to be less loyal to the company than full time employees who hope to benefit from the company’s success.
This story fits in with our “technological progress contributes to disinflation” theme here at TBL. As software tools allow businesses to form for fractions of the traditional cost, goods and services are driven closer to their marginal cost of production.

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Bullish on Stocks, Bearish on AI?

Americans are Really, Really Bullish on Stocks (WSJ) Newly minted millionaires are laughing all the way to the bank and betting that the rally that has driven the S&P up 18% this year has more room to run. The number of 401(k) retirement accounts at Fidelity Investments worth at least $1 million were up 31% from last year, a record high, and JPMorgan estimates stock allocations account for 42% of their total financial assets, most on record in data going back to 1952.
Stocks rebounded after a drop in early August, and investors are encouraged after Powell’s recent signals that a rate cut is but a few weeks away. Funds tracking smaller companies have surpassed prior monthly records set in November 2020 when the country was in the early stages of recovery post the Covid-19 crash.
“The S&P 500 has hit more than three dozen fresh records this year, on pace for the most in a calendar year since 2021”—as bullish sentiments reach their highest levels of the past year, some investors remain cautious as September is often one of the most volatile months for the stock market and some fear turbulent times in the face of a contentious presidential election. Others worry about the hype around the AI boom, something that was evident when Nvidia stock sank the day after it earnings results beat expectations.
It’s not just Nvidia that is under the intense scrutiny of investors, as they aim to sift through real and fake, winners and losers. Investors are now betting against AI darlings like Super Micro Computer and Lumen Technologies whose shares were up over 250% at various points this year. In August, Super Micro, Lumen, and Symbiotic became targets of bearish research reports questioning their valuations and pointing to “glaring accounting red flags” among other issues.

Yen: San Andreas Fault of Finance

T.Rowe Manager Who Predicted Yen Shock Sees Another Coming (BBG) The head of fixed-income at T.Rowe Price, Arif Husain, last year described rising interest rates in Japan as the “San Andreas fault of finance.” He is now warning investors that there is more market volatility after the nation’s rate hike in July resulted in a sharp reversal of the yen carry trade.
Abandonment of the yen carry trade (and associated liquidations) resulted in the Nikkei 225 Stock Average sinking by the most since 1987, triggering a surge in the VIX index measuring stock market volatility in the US. Economists even theorized that the Fed would cut interest rates between meetings, a move it usually reserves for times of crisis. Even as the yen has settled in a mid-140s trading range against the dollar, volatility remains.
In his report, Husain further wrote that he expects higher Japanese yields to attract the country’s life insurance and pension investors back into Japanese Government Bonds (JGBs) from other government bonds, something that would rearrange demand in the global market for fixed income. The yen had another strong week, leading to equity weakness in the rest of the world, and demonstrating that JPY is dictating risk direction.
Carry trade explained: as the yen strengthens (it did after Japanese rate hikes attracted currency flows), yen borrowings must be paid back in depreciating currency (a declining USD), triggering the closure of long risk trades funded by cheaply borrowing JPY. If the roll of the carry trade becomes too expensive (a higher interest rate this time versus last), risk is sold and the yen is purchased to repay JPY loans.

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Until next time,

TBL Thinks